Expert Commentary: Oil Market Analysis and The Week Ahead

• We currently see limited near term risk of a move back into the mid $30s with peak daily inventory builds in the rearview mirror amidst accelerating non-OPEC supply declines while global gasoline demand is on course to improve by 600k bpd y/y. This week’s sharp rally in reaction to Kuwaiti production strikes and jawboning about long-odds supply cut deals from Iraq and Nigeria served as good indications of the market’s increasingly thin layer of daily excess supply and general upside sensitivity.

• On the upside, we see limited short term risk of a move above $50 as OPEC members + Russia appear increasingly eager to pursue market share (we saw bearish data and/or rhetoric from Russia, Iran, Iraq and Saudi Arabia this week) while North American producers could exert pressure on a move over $50 by executing hedges en masse. Signs of heightened output from Iran, Saudi Arabia, Russia or flattening output in the U.S. could easily shift sentiment in a market with record-high (and expected to grow through year-end) crude oil and refined product inventories following a nearly 75 percent rally. We also see a certain degree of demand fragility with global refining margins at +5yr lows.

• As a result, we continue to see WTI in a high $30s / high $40s short term range and will keep waiting until those levels are breached to suggest directional options bets. In the meantime, we continue to like selling the WTI N16 $38/$43/$48 iron fly (short straddle, long strangle, $3.60 value end of day Thursday) believing oil will oscillate around the straddle. The structure profits $3.60 at $43 on a settlement, makes money between $39.40 and $46.60 and loses a maximum of $1.40 anywhere outside of $38 and $48.

Brent M16/N16 traded as high as +0.24 this week after labor strikes in Kuwait took over 5m bbls off the market. The spread has strengthened by more than 60 cents in April and has rallied $1.05 since January. The move hasn’t come without skepticism, however, and Energy Aspects believes that brent structure will not move solidly into backwardation until late 2016 or 2017. Further back in the curve, Brent N16/Z16 sold off its -1.28 top to -1.68 this week on a mix of trade group profit taking and also a delay in scheduled North Sea maintenance which sent the Brent Q16/V16 component reeling from -0.45 to -0.72. Going forward, these newly tight brent spreads will have to contend with Russia’s leadership commenting that they plan to add about 100k bpd (bringing output to 10.8m bpd) to the market in 2H16 while Iraq’s production has reportedly recovered back to 4.7m-4.8m bpd after falling to 4.2m bpd in February. Reuters currently estimates Iranian exports at 1.75m bpd in April (through the 19th) after averaging 1.6m bpd in March. Iranian leadership also repeated this week that they would not consider joining supply cuts until their production and exports returned to pre sanction levels of 4.2m and 3m, respectively, leaving room for growth of more than 1m bpd in both metrics. Related: A Good Day For U.S. LNG As Senate Passes Energy Bill

WTI M16/N16 was relatively flat this week between -0.85 to -0.80 and was able to hold on to recent gains with help from more draws in Cushing and PADD II while U.S. production continued to fall. WTI N16/Z16 ran into resistance at the -1.50 level yet again and traded near -1.60 on Thursday afternoon. As for trading flows there seems to mounting bullish interest in WTI Cal 16 spreads from trading groups in the market. The WTI CSO M16/N16 -0.50 call traded 0.6s and 0.7s more than 12,000x this week with a mix of funds and trading groups buying. It is worth noting, however, that spread option markets have maintained their bearish skew with the WTI M16/N16 -1.00p worth 12 cents on Thursday and the -0.60 call valued at 10 cents while the underlying spread printed -0.80s

Funds went on buying spree pre-Doha

Speculators added 68k contracts of net length in the week ended April 12th – the largest w/w change since January- in a clear change in sentiment following several weeks of watching the market and waiting to make a significant position shift. The majority of the buying came in brent (+50k w/w) and net length in the contract is now higher by 52 percent since February. The majority of the net length addition in WTI came from 20k of short covering while gross longs were flat. Gross shorts in WTI are lower by 57 percent since February while gross shorts in brent are lower by 64 percent. As for hedging activity, producer and merchant gross short positions in NYMEX WTI were flat near an all time high of 509k contracts.

As for demand, U.S. refiner inputs climbed 160k bpd to 16.1m bpd and are higher y/y by 1.3 percent. Total refinery demand YTD in 2016 is +2.5 percent y/y. Looking ahead, refiner margins continue to be an issue with the WTI 321 crack $9 below its seasonal average over the last five years and treading water near $18. As of Wednesday afternoon the HO/WTI crack traded near $12/bbl while the RBOB/WTI crack yielded $20/bbl. In the USGC, the LLS 321 crack traded near $10/bbl. Overseas margins remained even weaker with gasoil/brent at just $7.70/bbl. Related: Oil Price Rally Unwinds As Strike In Kuwait Ends

U.S. motor gasoline stocks fell by 110k bbls and are higher y/y by 6.2 percent while continuing to drop in line with seasonal norms. PADD II stocks dropped 1.1m bbls and are higher y/y by 3 percent while USGC stocks dropped 700k bbls and are higher y/y by 10.4 percent. PADD IB suffered a 1.7m bbl build due to a strong pickup in imports into the east coast. Domestic gasoline demand dropped to 9.4m bpd and is stronger by 4 percent y/y over the last month

RBOB futures followed crude oil and equities higher Wednesday and traded above $1.50/gl for a 9-cent rally from Monday’s low print of $1.402. Prompt spreads including K16/M16, however, told a different story and moved to multi month lows due to the larger than expected build in PADD IB. Farther back in the curve, RBOB M16/Z16 traded water between 21.0 and 22.0 this week.

Distillate data showed a 3.6m bbl draw which brought stocks to a 160m bbls for a y/y surplus of 24 percent. PADDs II and III lead the bullish data with draws of 1.1m bbls and 2.2m bbls, respectively but a build in PADD IB of nearly 1m bbls kept an otherwise completely bullish report in check. Domestic distillate demand jumped an impressive 425k bpd to 4.275m bpd (-1 percent y/y) and exports at 1.03m bpd are also lower y/y by 1 percent y/y. Related: Iran’s Dilemma: Too Much Oil And Not Enough Ships

Gasoil M16/Z16 continued to rally this week moving to -21.75 for a $14/t rally since April 5th with help from more stock draws in Singapore and Amsterdam-Rotterdam-Antwerp. Singapore stocks remain 10 percent above their 2011-2015 seasonal avg., however while ARA stocks are higher by 43 percent. Gasoil futures traded up to $393/t this week for the first time since December.